Tax Rates and Entrepreneurship

By James Kwak

My friend and co-founder Marcus Ryu wrote an op-ed in the Times today. Here’s how it begins:

The tax cut framework recently put forward by President Trump relies on a central claim: that reducing taxes on corporations and wealthy individuals will open the wellsprings of entrepreneurship and investment, turbocharging job growth and the American economy. Were this premise true, reasonable people might countenance giving a vast majority of benefits to the very rich, as Mr. Trump’s plan does, in exchange for greater prosperity for all. But it’s not.

I don’t have a lot to add, since Marcus makes the case very well. I’ll just expand on two of his points. One is that lower tax rates do not actually encourage people to start companies. When we started our company in 2001, there were a lot of factors I considered: the risk of leaving a well-paying job in the middle of a recession; my simultaneous move across the country to a place without a lot of technology jobs; the difficulty of raising money from venture capital firms; the relatively large pool of talented developers looking for interesting jobs; the poor competition in the field we had chosen; the difficulty of saying “no” to Marcus; and so on. Tax rates weren’t on the list. As I like to say, I didn’t even know what the tax rate on capital gains (the one that matters for startup founders) was, so it’s hard to see how it could have had any effect on me.

The second point, which is only a bit more complicated, has to do with the impact of corporate tax rates on company behavior. One of the common arguments for a corporate tax cut is that it will encourage capital investment, which will create jobs. This happens, in theory, because a lower tax rate increases the after-tax value of corporate profits (technically speaking, expected future dividends) to shareholders. This means investors will pay more for the stock of what is otherwise the same corporation. For the most part, that just results in a one-time increase in the stock price in the secondary market, which has no direct impact on the company itself. The company only benefits if it issues new stock in a secondary offering, because it can raise a bit more cash for the same number of shares. As Marcus points out, however, a corporate tax cut can only increase investment if companies are actually having trouble raising capital, which has emphatically not been the case for the past several years. In other words, if we actually want to increase capital investment by U.S. corporations, lower tax rates are just about the last place where we should look. (Raising workers’ wages, to increase demand for the stuff those corporations sell, is probably a better place to start.)

I haven’t been writing about the Trump tax cut because (a) a bunch of personal reasons, (b) intellectually speaking, it’s like shooting fish in a barrel, and (c) lots of other people with much bigger audiences are doing it anyway. So please read what Marcus has to say.

4 thoughts on “Tax Rates and Entrepreneurship

  1. The fallacy is attractive because it’s easy to confuse revenues with profits. A tax on revenues or operations, for example a transaction or land use tax, cripples a business unless it has high enough margins to overcome it. A well-designed tax on profits has no effect on a business in perfect equilibrium, whose margins are near zero.

    In order to promote equality and have a sane discussion on taxation in today’s capitalism we need to clearly separate personal wealth from investment funds. Personal wealth is what Elon Musk can spend on his house. It has to be small and highly taxed. Investment funds is what he can use to create rockets, AI, and fast trains. Taxes on this should be low but other restrictions, like political neutrality, should apply.

    The two, personal consumption and investment discretion, are different powers. Today they’re muddled, even for accountants, and that allows people to say “You can’t tax Elon or he would not invest”. They need to be un-muddled and addressed differently to bring inequality under control.

  2. Wheeoh, I feel as if I’ve been in the courthouse for the last two months rather than vacation, welcome back James.

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